The discount rate
*Interest rate used to reduce the value of future DB pension payments back into todays value when calc’ing a transfer value
SO
*Higher discount rate, future pension discounted more, lower CETV
*Lower discount rate, future pension discounted less, higher CETV
What reduces a CETV
Lower scheme funding
*Trustees apply more conservative assumptions
Higher discount rate (inversely correlated to CETV)
*Higher discount rate = higher discount factor i.e. less money
Lower revaluation
*If assumption is lower then future pension grows more slowly so future DB benefit worth less thus CETV decreases
Higher annuity rates (Inversely correlated to CETV)
*Higher annuity rates mean insurers earn more from the money they invest, so they need less capital to provide the same pension. Because the liability is cheaper to secure, the scheme can offer a lower CETV.
DB cash on death lump sums
*lump sums payable because member dies (once pension starts cannot get this anymore)
*usually 3x or 4x salary
*can come from uncrystallised or crystallised DB rights
*Death BEFORE 75 tax free if paid within 2 years (BCE so tested against LSDBA)
*Death AFTER 75 taxable at marginal rate (not a BCE)
DB guarantee period lump sums
*Member was already receiving pension AND chose a guarantee period (if pension has not started cannot get this)
*if die within guarantee period remaining unpaid instalments are paid out (usually 5 or 10 year)
*Death BEFORE 75 tax free if paid within 2 years (BCE so tested against LSA/LSDBA)
*Death AFTER 75 taxable at marginal rate (not a BCE)
DB Dependant’s survivors pension
*capped HMRC ongoing income for dependant usually 50-67% of members pension (death before 75)
*ongoing income for dependant usually 100% of members pension + 5% PCLS (death after 75)
*always taxable as income (no BCE testing as not a lump sum)
Contracting out in a DB scheme
*DB members gave up SERPS/ S2P in return for scheme benefits at least as good into their scheme pensions
*Type 1 GMP (Guaranteed Minimum Pension)
- DB scheme must provide benefits at least equal to SERPS
- which cannot be used to boost PCLS
- member dies = 50% dependants pension to be paid
*Type 2 Requisite benefits (from 1997)
- Replaced GMP, same idea but much simpler to administer
- based on 1/80th accrual rates
Critical Yields
*For when a DB member wants to transfer to DC
*CY is the return needed in the DC pot to match the DB promises
*Higher CPI assumption, DB pension grows faster, so DC pot must grow more, so critial yield higher
*Lower CPI assumption, DB pension grows slower, so DC pot needs less growth Critical yield goes down
*Type A shows annuity purchase at 65, 70, 75
*Type B shows return needed to maintain income
*critical yield is the full fat picture, hurdle rate just shows what you need to match the starting level pension
DB Short service refund
*DB members ALL get their own contributions as refunds if leaving within 2 years
- members taxed at 20% (first £20k), 50% above this
-employer contributions returned subject to 35% tax charge or leave in scheme to fund others
DB retirement options and increases
*on retirement
- do you want to take a lump sum?
- do you want to take early/ deferred pension?
- do you want to take pension or an annuity (which administrator chooses for you, diff from DC shopping around)
*pre 6 April 2005 5% increases since then only 2.5% each year
DB ill health lump sum payable
*only where:
- life expectancy less than 12 months
- benefits not yet crystallised
Safeguarded rights are
*pension benefits that come with a guaranteed level of income
IN PAYMENT DB contracted in escalation rules (GMP and Requisite benefits)
*Benefits before April 1997 = none
*Benefits from April 1997 to April 2005 = CPI capped at 5%
*Benefits after 6 April 2005 = CPI capped at 2.5%
*GMP accrual ends (5 April 1997), and requisite benefits accrue from (6 April 1997)
DEFERRED MEMBER DB contracted in revaluation rules (GMP and Requisite benefits)
*Pre 2009 CPI/ RPI capped at 5%
*Post 2009 CPI capped at 2.5%
DB scheme liabilities and AA bond prices
*If AA bond prices rise their yields fall, a lower yield = a lower discount rate which gives a higher present value of liabilities
*If AA bond prices fall their yields rise, a higher yield = a higher discount rate which gives a lower present value of liabilities
Actuarial valuations to be aware of
*Section 143 - PPF entry valuation (Is the scheme underfunded)
*Section 179 - PPF levy valuation
*Triennial funding valuation - technical provisions (i.e. the scheme funding level)
*CETV valuation - member transfer value
*Technical provisions are the valuation of the scheme’s liabilities
Accounting valuation
*IAS 19, must include scheme funding on a company’s balance sheet
Non-explicit scheme pension
- ‘Scheme pension’ = a DB pension in the exam
Critical Yields
*Best practice only
*Type A for annuity at ages, 65, 70, 75
*Type B for budget, you want a set income
Public service DB benefits
*Retire pre April 2015 - final salary
*Retire post April 2015 - career average
*Retire early and either final salary or average of best 3 years from the last 10 pre/ post April 2015
*PCLS usually 120/80ths final pensionable salary
How to convert DB pension growth into an AA value
(16/1)
Transfer Value Comparator
*Shows how the DB scheme pension compares to the cost of buying the same income using a lifetime annuity today
*TVC must assume 4$ setup cost and 0.4$ product charge which are both fixed FCA assumptions
